In both domestic and international transactions, upstream interests can be acquired or divested in a number of different ways. Although it will vary from jurisdiction to jurisdiction, the rights acquired are typically governed by a license/concession/production sharing agreement, a joint operating or venture agreement, and any other ancillary agreements (for example, petroleum processing, transportation and sale agreements). The sale process will involve the negotiation of the legal, tax and business objectives of both the seller and the buyer in order to arrive at a structure acceptable to both parties.
What legal considerations should be kept in mind during these negotiations? Some will of course be unique to the assets, host country and corporate structure of the buyer and the seller. Other common issues appear repeatedly in negotiations:
Asset purchases offer a buyer the advantage of being able to select on a case-by-case basis which assets and liabilities are transferred to it. Exceptions may apply in certain jurisdictions, for example when a buyer inherits decommissioning liabilities associated with a license along with the asset. The buyer will want to cherry-pick the assets that offer a financial or strategic value, while insulating itself from any unwanted liabilities that may be associated with those assets. To give the buyer added protection, the asset purchase agreement generally requires the seller to indemnify the buyer against any historical liabilities.
Lock, Stock and Barrel
Buying assets through the acquisition of a trading company results in the opposite situation. The buyer acquires all of the rights and liabilities of the target company, known and unknown, including those arising prior to the acquisition. The buyer will, however, have greater comfort that it is acquiring all of the rights required for the operation of those assets. Ordinarily, the buyer will ask the seller to disclose all liabilities of the target company in order to identify and quantify the risks associated with the purchase of that company. If any undisclosed liabilities surface after the transaction completes, the buyer typically has a claim for breach of warranty against the seller. This right to claim will usually be heavily restricted by the seller, who wants a clean break from the assets. The seller generally negotiates limits on these rights to claim by capping the time and amount of any such claim.
Asset purchases involve a change in the asset holder. As a result, they do not automatically transfer contracts (other than employment contracts in a relevant transfer) or existing trading arrangements to the purchaser. Invariably, transfers require the consent of the other parties to the various contracts, adding time to the sale process. Other parties may seek to impose new terms to gain advantage from the change, or even refuse the transfer.
In a share purchase, the relationship between the target company and its contractual counterparties and suppliers does not change; it is only the ultimate ownership of the company that is transferred. Since they are exempt from the transfer issues outlined above, share purchases are often simpler to implement than asset purchases.
Third-party consents may be required as a result of either an asset or share sale. An additional concern arising from an asset sale is the possibility that the transaction may trigger a preemption provision in the underlying upstream interest documents. Preemption clauses (sometimes called preferential purchase rights) give existing interest holders a priority right to acquire the upstream interest offered for sale on the same terms and conditions as those agreed to by a third-party purchaser. Although preemption issues are generally triggered only on an asset sale, many upstream contracts contain a change of ownership (change of control) clause, which might trigger the early termination of that contract in the event of a share sale.
Share acquisitions require the buyer to undertake extensive due diligence into the financial, legal, tax and commercial position of the target company, since all potential liabilities are being transferred. If the target company has had a long and eventful history, the cost of such due diligence may be prohibitive and may still fail to expose all the historical liabilities of the company. In such cases, the diverging interests heighten between the buyer (who wants indemnities against all undisclosed liabilities) and the seller (who seeks a clean break from the target company). In smaller deals, the costs of due diligence may be disproportionate relative to the value of the transaction, and an asset rather than a share deal will often be preferred as a means to control the costs of the sale process.
Share acquisitions create their own additional complexities. A target company may own other assets or be party to contracts that the buyer is not interested in acquiring. Therefore, a share purchase requires either the seller or the buyer to strip out of the target company contracts, assets and liabilities that are not the subject of the transfer. The seller may not wish to undertake this exercise unless it is assured of the sale going through, thereby causing delay. After the target company has been acquired, the buyer may wish to transfer the constituent assets into a known or clean entity and liquidate the target company in order to remove from its books a company it knows little about.
This article discusses a number of the common issues arising in the acquisition or disposal of upstream interests. The relevance, however, of these issues to a particular matter varies from deal to deal. Ultimately, the commercial realities of the transaction, as well as the priorities and relative negotiating position of the parties, dictates the form and nature of any upstream interest sale.